Under the amendment to the Republic of Azerbaijan Law on Securities Market passed in July 2023, the National Depository Center (NDC) was granted the right to provide limited banking services in assuming the role of a settlement agent - a function currently performed by existing commercial banks, Report informs referring to the Asian Development Bank (ADB).
Consequently, the NDC can provide clearing and settlement services not only for existing securities accounts but also for newly opened cash accounts.
The NDC holds the cash accounts of participating institutions and operates an embedded funds transfer system, allowing for settlement of securities and funds within a single entity.
Thus, as the ADB notes, the NDC will be able to directly establish trading limits and control transaction collateral, while investment companies will gain the opportunity to work through a "single window" for securities and cash settlements.
In this regard, the ADB proposes a phased infrastructure development plan.
In the short term (within the basic model), the NDC will replace commercial banks in the role of settlement agent, maintaining the current guarantee mechanism for DVP2-type settlements (delivery versus payment on a net basis). For DVP1 transactions (gross settlements), a gradual phase-out of mandatory guarantees in favor of market-based risk management mechanisms is proposed.
The development of a comprehensive financial market infrastructure is also envisaged, taking into account economies of scale, concentration risk management, and the Principles for Financial Market Infrastructures (PFMI). A detailed implementation plan for NDC functions as a single settlement agent, including modern risk management tools, is also needed, the bank believes.
In the medium term (within the recommended model), the ADB proposes the creation of a central counterparty (CCP). This will enable Azerbaijan to comply with international PFMI standards, reduce costs for market participants, and enhance investment attractiveness through the introduction of a default management system and clearing funds.
The ADB also notes that to ensure uninterrupted settlements, the possibility of the Central Bank providing intraday liquidity to the NDC and investment companies is being considered. This will help avoid delays, particularly in the government bond market.
To implement the proposed measures, a set of reforms aimed at the deep transformation of the financial system is envisaged.
These include optimization of the account structure and interaction architecture between commercial banks and the Central Bank based on a feasibility analysis; modernization of the collateral management system, including the introduction of market haircuts and improvement of collateral monetization procedures; development of margin collateral mechanisms and strengthening of client asset protection; ensuring settlement completion no later than the value date and establishment of a clearing fund; liquidity support through intraday repo and CBA overdrafts with a review of access policies to its accounts; reform of DVP models, including improvement of guarantees for DVP1, introduction of netting, and acceleration of intraday settlement cycles; preparation for CCP function implementation, including clearing, margin requirements, guarantee fund formation, and creation of a risk coverage system (default waterfall).
As noted in the ADB technical update, the implementation of these recommendations will create a solid foundation for growth in trading volumes and the transformation of Azerbaijan's capital market into an effective instrument for attracting investment.